The Separation Of Economic Myths From Reality

The economic myths surrounding markets that affect the global economy are in plenty. It is important to separate myth from reality if you would like to understand how the markets operate. Here are some examples of common economic myths.

Myth: Panic declines are caused by short-selling. The majority are often quick to blame short positions for causing the panic any time there is a stock market crash. This has been the reason for government economic investigations during each panic.

Reality: Short positions in stock are usually created by the borrowing of stock followed by selling it on the market. This means that in reality, each short position results in a long position. The first one is the long position from whom the short borrows while the second one is created by those that buy stocks from the short seller. At any given time, you can expect short positions to be outnumbered 2:1 in the share markets if you assume that all the outstanding stock was borrowed initially.

Short positions usually account for just a small portion of the total outstanding positions. It is thus impossible for short positions to ever outnumber long positions. It is only possible if there is unlimited naked short selling, which has never happened before.

Futures requires two players to balance each contract: one short and one long. In commodities, short positions can only match long positions at best. Short positions can never outnumber the long positions even in the most economic bearish markets.

Myth: Interest rates offer incentives to sell or buy real estate, bonds, or stocks at the expense of any other stimuli.

Reality: Interest rates tend to decline in bearish markets and rise in bullish markets. No empirical evidence suggests that lowering interest rates can stimulate economic growth. Lowering interest rates lowers the income of those with cash. People typically never borrow, even at 1 percent, if there are no profits in sight. Interest rates decline during depressions usually providing the incentive to invest overseas. If capital is unable to earn money domestically, it starts shifting overseas. Lowering of interest rates cannot stimulate economic growth without a perceived investment opportunity.

Myth: If a country raises the base interest rate, its currency will rise since a greater return is likely to attract international capital.

Reality: The new problem is the lack of depth in this fundamental analysis. Nothing ever happens without reason. Without exception, it is always the combination of many different trends.

The inconsistent relationship between the value of a given currency and the interest rates is a product of many economic factors that add to a nation's underlying confidence along with its currency's value. If the only factor determining the superior value of a given currency were interest rates, everybody would be flocking to countries such as Argentina where interest rates rose to 300 percent of Europe in the midst of a debt crisis.

The interest rates myth and their effects within the global economy are however not one-dimensional. If what is required to attract capital was high-interest rates, why do they tend to rise when capital is gone? You can compare this to a loan shark: If the lender refuses to accept your credit, you have no option but to go to a loan shark at a rate that's much higher.

Capital typically follows a bell curve, and higher interest rates attract it to a certain extent. However, once capital is spooked, it usually flees, and what is witnessed is an exponential rise in interest rates as confidence dwindles. If the value of currency collapses in value, interest rates usually rise exponentially. No relationship ever stays linear and will often change economic direction and follows a bell curve.

Reality: It would be glorious if equity markets could be simplified to such an original rule. If it were true, then every reader would by now be a billionaire. History is full of examples that say otherwise.

Myth: Bond prices can help to determine stock prices and vice versa.

Reality: In the relationship between stocks and bonds, what counts is nothing besides confidence that cyclically swings back and forth between the two instruments. It is only when everything is at equilibrium that you find stocks and bonds trading synchronously trading together. If the underlying confidence in a particular sector is shaken but not in the other, massive divergences will occur.

Cyclical trends are not just confined to one market. Spread traders understand that huge discrepancies can happen between any two particular instruments. Nothing ever stays the same. Everything within the global economy vibrates with oscillating trends. Massive extended patterns exist in different aspects from unemployment to capital flows.

Myth: To inject cash into the economy to stimulate growth, Central Banks can buy back government bonds.

Reality: One major assumption of the myth is that domestic investors only hold bonds. If bonds are held by foreign investors as is the case for close to 40 percent of all sovereign debt, buying back the bonds would only translate to exported cash but no stimulation of the economy.

Economic Fallacy

The economic myths present here exposes the fallacy of fundamental analysis. Fundamental analysis is geared towards reducing the intricacy to just one cause and effect. However, this is a Complex Adaptive Dynamic System, and everything is connected on a global level. It is simply not right to reduce such an intricate system to just one cause and effect.

Bonds and stocks swing with confidence since people never sell or buy without it. While many might argue that trust is impossible to measure since it is some imprecise element, the best way to determine confidence is movement of the market price, which is the greatest test of all time. If you monitor the price actions in the market and world capital trends, it is possible to gain a genuine sense of confidence in the underlying economy. Capital flees once confidence collapses.

History is always self-replicating, but you will be hard pressed to find a point in time when history was repeated in the very same way throughout different economic sectors simultaneously. What usually tends to happen are the overall trends towards oscillating interrelationships and divergences.

Analyzing the global economy is more than just analyzing the prices of stocks in isolation. The revelation of the secrets behind significant oscillations will never happen until we start analyzing and correlating the results on a global level with the fundamental structural changes.

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